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Analysis

China – How Much Trouble for FX?

China is once again a hot spot for geopolitical uncertainty and social unrest. This week China unveiled a plan to take a stronger stance on antigovernment protests and dissents in Hong Kong. They proposed new security laws that would punish opposition to the mainland. While the details have not been revealed, this would be a major blow to civil liberties and the city’s autonomy. The fear is that this would elicit a strong response from the US who could see this as a reason to reexamine Hong Kong’s special trade status with the US. In recent weeks, tensions have flared between the US and China with the US calling for China to take responsibility for the COVID-19 outbreak. The US threatened to delist Chinese companies from exchanges, restrict new companies from listing, cap American exposure to Chinese investments, warn of further tariffs / “economic penalties” and approved a controversial arms deal with Taiwan. Investors worry that this latest move on HK will give the US the perfect opportunity to rebuke China further by threatening to revoke HK’s special trade status and leave them subject to the same restrictions as China.

The question is how much trouble could US-China trade tensions be for the financial markets. The latest flare up drove the Australian and New Zealand dollars sharply lower on Friday. US stocks fell but USD/JPY held steady. If the US were to change HK’s trade status, the psychological impact would be significant with currencies and equities falling sharply but on a longer term basis, the reality is that US and HK export very little to each other so the trade impact will be limited. Yet the real fear is HK’s financial industry and whether China will retaliate by restricting American businesses in HK. The mere possibility could cause major disruptions in the financial markets.

We don’t think either country will take it that far. Threats could be made but the costs are too high especially for China who probably thinks its smarter to wait 6 months to see if a new US President is elected in November. The US-China trade war haunted the markets throughout 2019 and that did not stop stocks from climbing to a record high. So at the end of the day, these negative headlines will hurt currencies and equities but the impact that China worries have on the markets should be short-lived.

The economic calendar next week is relatively light with US markets closed for Memorial Day on Monday. The most important US event risks will be consumer confidence, which should be stronger, revisions to Q1 GDP, personal income and personal spending (which should be weaker). Fed Chairman Powell also speaks at the end of the week. The main driver for the greenback should be risk appetite.

For the euro, Germany’s IFO report and Eurozone inflation data will be the most important. EUR/USD hit a wall after rising above 1.10 this week. We expect the currency to continue to outperform especially as we look forward to improvements in German business confidence. There are no major UK economic reports on the calendar but nearly all of the data this week was disappointing including today’s retail sales which fell by a historic amount in the month of April. The Bank of England is widely expected to increase stimulus next month and reinforce their open mindedness to negative rates. As a result, sterling should continue to underperform other major currencies. 

Canadian retail sales fell 10% in the month of March, driving the loonie lower against the greenback. The decline was less than expected especially when we exclude auto purchases – spending ex autos fell only -0.4%. March GDP numbers are due next week but Bank of Canada Poloz and Williams’ speech will be the main focus. With no major economic reports scheduled for release, the Australian dollar will take its cue from ongoing developments in China. The New Zealand dollar on the other hand has trade data, a Financial Stability Report and comments from Reserve Bank Governor Orr. 

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